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Tuesday, July 29, 2008

Types of Fixed Income Securities

From The Hoss's Mouth


Today, Hoss Cents Free Financial Money Magazine discusses fixed income securities. There are four major types of fixed income securities: Bonds, Debentures, Stripped Bonds and Mortgage-Backed Securities. The Hoss will provide some detail of each, and you can evaluate which are best suited for your risk tolerance level. Somewhat like handicapping a racing form, only with fewer variables. The cost of purchasing any of these fixed income securities is by commission built into the purchase price. You earn money from the interest paid and/or a capital gain. Note: You could also have a capital loss.

fixed income securities

Bond: A fixed income security that is a secured loan to a company or government. The security is in the assets of the company or government. Length of term to maturity is usually one to thirty years. Interest is generally paid at a fixed percentage per year. The credit rating of the issuer and interest rates at time of issue will determine the interest rate. The greater the risk, the higher the interest rate. In the event of a default and subsequent disposition of assets, tax authorities, employees and creditors rank ahead of the bondholders. Preferred and common shareholders rank behind the bondholders.

Debentures: The principal difference between bonds and debentures is in the security. Debentures may be secured by the issuer's general assets not specific company assets. However, it is still considered a fixed income security.

Stripped Bonds (Strips): With this fixed income security, the principal portion of the bond and the interest payment coupon are separated from each other and sold as individual investments. Eighteen months to thirty years is the term range of this fixed income security. Regular bonds with similar credit quality and terms usually have lower yields than stripped bonds. Strips mature at face value, but are sold at a discount. The difference between the value at maturity and discounted price you paid for the strips is your interest income. You should expect a greater discount the longer the term to maturity. The income you receive is deferred, so The Hoss suggests it may be wise to seek the advice of a tax consultant before investing in strips.

Mortgage-Backed Securities (MBS): This type of fixed income security is a pool of mortgages in which you have a partial ownership. You should expect a term range of one to ten years. MBS usually make monthly income payments on fixed rates of return. An MBS is fully guaranteed by Canadian Mortgage and Housing Corporation.

That sums up today's post on fixed income securities. Now it's time for The Hoss to munch on some oats.

Stay on track,

The Hoss

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